Investment Methods, Individual and Estate Planning

 Making financial investments by an individual requires careful consideration of the method used to make the investment. The method of investment is as important and critical as the selection of the investment itself. Though not much thought is given to the method of investment and all efforts go only towards the selection of the investment. A good investment selection can be rendered difficult to realise its benefits when the method of investment is not optimal.

The common methods of investment available to an individual investor (the “Investor”) are ‘in the name of the Investor’, ‘joint name of two or more Investors’, ‘a private investment company’ whose shares are held by the Investor (the “PIC”), a ‘trust’ whose settlor is the Investor and the beneficiaries the Investor and other persons.

To analyse which of the above method of investment is an optimal investment method, it is necessary to understand the expectation of an Investor either at the time of exit from the investment or to pass on the investment to heirs. In either case, the main factors would be to minimize capital gains tax, if any, (i.e. tax efficiency), immediate availability of the money realised from the sale of the investment; no or minimum cost to get back the money or the investment; and smooth transfer of the investment to heir in cases of the Investor’s demise.

Let us analyse the impact of each method of investment vis-à-vis main factors as a function of uncertainties of life.

If the Investor is alive at the time of exiting the investment except for the tax efficiency the other three factors may not be relevant. However, all the other main factors become relevant if the Investor is hit by uncertainties of life and is no more alive. In such a situation, neither the money will be immediately available nor will there be a smooth transfer of the investment to heir(s) till the inheritance process is completed which may take months to years. Further, the inheritance process itself may lead to substantial costs which may vary from 2% to 10% of the estate of the Investor depending on the domicile of the Investor and whether the investment holdings are multi-jurisdictional or not.

When the investment is held through a PIC and the Investor is alive at the time of exiting the investment the main factors may not be relevant including the tax efficiency since the PIC must have been set-up for tax efficiency. However, all the other main factors become relevant as in the case when investment is held in the name of the Investor if the Investor is subject to the uncertainties of life and is no more alive. Though at the first level i.e. the PIC there is no adverse impact since the investment continues to remain in the name of the PIC. However, the heir cannot be paid dividend by the PIC if the PIC exit the investment. The reason is that the shares of the PIC held in the name of the Investor are to be transmitted in the name of the heir(s). For the transmission to happen successfully the full succession related process has to be completed before the shares can be re-designated in the name of the heir(s). Consequently, there will be delay, cost and a succession process to be followed for the heir to get the money i.e. the similar adverse situation when the investment is held in the name of the Investor.

What is the situation when the investment is held through a trust? A trust is a contractual relationship with three distinct parties i.e. the settlor, the trustee and the beneficiaries. These three parties can be the same person or different persons. The critical difference for the trust is that the trust continues to remain in existence even if any of the three parties die and there is a predefined understanding to replace the trustee which ensures continuity of decision making for the trust. Assuming the Investor invests through a trust whose settlor is the Investor, trustee is a professional trustee company and the Investor is also a co-beneficiary with other persons (heir(s)). Let us analyse the impact on main factors if the Investor dies. On the death of the Investor, the investment will be continued to be held in the name of the trust. At the time of setting up the trust, the Investor would have chose a trust law and trust administration place to give it tax efficiency. Nothing changes on the demise of the Investor and the trust continues to have the tax efficiency. After the death of the Investor, if the trustee desires to sell a part of the investment and distribute it to the beneficiaries, the trustee can sell some investment and distribute the money to the beneficiaries within the normal timeline without incurring any additional costs. Finally, there is no need to follow any succession related process since the investment continues to remain in the name of the trust and the trustee will distribute the money to the beneficiaries as per the terms of the trust deed. Further, there is no adverse impact of having investments in multiple jurisdictions. In short, the trust method of investment is highly efficient on all the main factors.

The investment and its management through a trust is highly flexible and can be customised to meet specific needs and requirements of each Investor by use of revocable or irrevocable trust, discretionary or non-discretionary trust, having a provision for protector, having different categories of beneficiaries like primary and secondary etc. Certain trust structures can provide the added benefit of protection of the trust asset from creditors and bankruptcy proceedings which is not available for any other type of holding i.e. individual, joint holding or PIC.

How does the above methods of holding compare with the ownership in the joint name i.e. joint tenancy. The joint tenancy does eliminate some of the issues associated with ownership in individual name or through PIC but this also add some other complications. If all the joint owners die together then all the drawbacks associated with holding in an individual’s name will be encountered. Further, whenever the last joint holder of the investment dies, again all the drawbacks associated with holding in an individual’s name will resurface. The additional complication which is unique to this case is that the creditors of all the joint holders can make separate claims for whole of the investment. So, joint tenancy is at best a stop gap arrangement but not an effective solution.  

The above described scenarios are agnostic to the investment type i.e. financial assets or real estate or other valuables. Further, the uncertainty of life is not confined to the death but any situation which incapacitates the Investor’s decision-making abilities. The problem of delay and costs get exacerbated when the investments are held in multiple jurisdictions requiring separate succession process in each jurisdiction.